Due Diligence: A Checklist for Selling Your Business
Once you've received an acceptable offer to buy your business, and you've negotiated the terms to everyone's satisfaction, it's time for due diligence.
Every purchase agreement for a business will include a few contingencies, and one of them is certain to be a due diligence clause. This clause is in place to protect the business buyer should any of business's financial or operating details differ from what was presented during negotiations.
Documentation to Provide
Standard due diligence will include various aspects of your business, including financial documents, legal issues, operations, employee relations, as well as all assets, products and customer data.
Due diligence can get complicated, so your accountant, attorney, broker, or all three should be deeply involved in this process to ensure it goes off without issue.
Here is a checklist of items you should be prepared to provide the buyer:
1. Financials
This includes audited financial statements over the last three years. If you're like any other business owner, you've been running your business in such a way as to minimize taxes. That almost certainly means minimizing profit on paper. Be prepared to account for your claimed discretionary earnings, and answer questions about any unusual add-backs. Your accountant should meet with the seller’s accountant to review, verify and possibly recast all the numbers.
- Financials: Income statements, cash flow statements, balance sheets, general ledger, accounts payable and receivable
- Statement of SDE
- Credit report
- Tax returns for at least the past three years
- All debts, their terms and any contingent liabilities
- Analysis of gross profit margins
- Analysis of fixed and variable expenses
- Gross profits and rate of return by each product
- Inventory of all products, equipment and real estate, including total value
2. Business Structure & Operations
Expect the buyer to ask how the business is structured and how it makes its money. This could include any information about competitors, market penetration or trends in the industry that could determine the company’s future earnings potential. The buyer may ask to review and verify your business model, customer base, products and services, as well as labor, materials and operational costs.
- Company’s articles of incorporation and amendments
- Company’s bylaws and amendments
- Summary of current investors and shareholders
- All company names and trademark brand names
- All states where the company is authorized to do business
- All products and services, including production cost and margins
- Business compliance requirements
- Marketing plan, customer analysis, competitors, industry trends
- Data on sales and customer acquisition channels
- Company’s brand identity, including logo, website and domain
3. Contracts & Liabilities
Does your business have any partnerships or joint ventures with other companies? Does your business have any existing loan agreements, lines of credit, equipment leases or other liabilities? Expect the buyer to ask about any obligations or agreements in place that they may be expected to comply with or respond to in order to do business.
- All nondisclosure or non-compete agreements, any guarantees
- Company purchase orders, quotes, invoices or warranties
- Security agreements, mortgages, collateral pledges
- Letters of intent, contracts, closing transcripts from mergers or acquisitions
- Outstanding liens and lien waivers
- Distribution agreements, sales agreements, subscription agreements
- All loan agreements, material leases, lines of credit or promissory notes
- Contracts between officers, directors or principals of the company
- Stock purchase agreements or other options
4. Customer Information
Prepare all customer lists and databases. Expect to be asked about your largest customers in terms of sales, as well as what they’ve purchased over the last 2-3 years. Also, expect to be asked how customers are acquired and retained, as well as whether or not they’re on renewable subscription agreements.
- All customer databases, subscriber lists and sales records
- Copies of standard communications and correspondence
- All advertising programs, marketing programs and events
- Purchasing policies and refund policies
- Any customer research data, white papers or research
5. Employee Information
Prepare your company’s employee roster and an organizational chart. Identify your key employees and what their responsibilities entail. Try to offer this new potential business owner history on your most important employees, and your advice regarding incentivizing them to stay under new ownership.
(See why 'Retaining Key Employees Is Critical to Selling Your Business')
- Employee roster and organizational chart
- Employee contracts and independent contractor agreements
- Payroll information and employee tax forms
- Human resources policies and procedures
- Employee benefits, retirement plan and insurance
6. Legal Issues
Expect buyers to ask if there are any outstanding legal issues or ongoing litigation that they need to know about. They may want to know who represents the company and if the company has proper insurance in place. They may also want to know if the company has all the proper licenses and permits in place.
- All attorneys and law firms representing the company, area of practice
- Pending litigation or threats of litigation
- Any unsatisfied judgements
- All insurance coverage and policies
- All professional licenses and permits
7. Physical & Real Assets
Prepare a full inventory of all your company’s property and its current market value, including automobiles, equipment, real estate, and sales inventory.
- Real estate, including office locations, warehouses, current leases and titles
- A schedule of all fixed assets, including product inventory, furniture, fixtures and equipment
- Any automobiles or boats
8. Intellectual Property
This includes trademarks, copyrights, patents or other exclusive intellectual information that is owned by the company.
- All company’s patents, trademarks and copyrights
- Product inventions, formulas, recipes, or technical know-how
- All rights owned data and digital information
- All work-for-hire or consulting agreements
Be Prepared to Give a Little
It's not uncommon for issues to surface during due diligence. Generally, there will be subtle discrepancies in financials, or operational issues you didn't think to offer earlier in the process.
Modest adjustments to price, or financing terms can usually alleviate these concerns, and save both parties the deal falling apart at such a late stage. In general, once you've got this far, it's better to give a little to close the deal.